There are many reasons why two companies may choose to combine into a single entity. Expanding into new territories, adding technologies, reducing costs, eliminating competition, boosting revenue, and increasing market share are just a few examples.
The legal joining of two or more businesses is called a merger or an acquisition, depending on the circumstances. The action may be “friendly,” meaning it is mutually agreed upon and benefits both companies, or the action may be “hostile,” meaning there is some opposition and one company benefits significantly more than the other.
The two terms are often used interchangeably, though legally and financially they have significant differences. Because the word “acquisition” sometimes carries a negative context, some companies choose to use the term “merger” to avoid public disapproval. In this article, we will use the terms in their legal and canonical sense.
What is a Merger?
A corporate merger is the legal consolidation of two or more business entities into one. Typically, the two companies will be of similar size and scope. The assets and liabilities of both companies are generally combined, and new corporate leadership is set up to include people from both organizations. Stocks of both companies are retired, and new stock is issued.
In many cases, one company name and brand survives, while the other ceases to exist. An example of this is the 2019 merger of United Technologies Corporation and Raytheon Company, where the Raytheon brand is the survivor. In other cases, both brands continue, giving us sometimes awkward company names such as Keurig Dr Pepper and Kraft Heinz. Less often, neither brand continues, but an entirely new company is created. This was the case when Yahoo and AOL merged in 2017 to form the company called Oath.
One of the hallmarks of a true merger, as opposed to an acquisition, is that neither company buys out the other (though exchanges of stock may occur). Another characteristic of a merger is that significant restructuring occurs in order to take advantage of the best assets of each company.
True mergers (sometimes referred to as “amalgamations” or “mergers of equals”) are relatively uncommon. It is rare to find two companies so alike that both will benefit equally by combining. Most of the business consolidations that are called mergers are actually acquisitions.
Examples of Winning Mergers
One of the most successful corporate consolidations was the 1999 merger of the Exxon and Mobil petroleum companies to form ExxonMobil, a major player in the worldwide oil industry.
Another successful merger is that of the online brokerages Charles Schwab and TD Ameritrade in 2019. The combined company has taken a massive lead in the online investment industry.
Examples of Failed Mergers
The 2001 merger of America Online and Time Warner was a disaster from the beginning. Anxious to take advantage of emerging new media technologies, the companies rushed into a deal without proper due diligence. After just one year, the combined company posted a net loss of 99 billion dollars.
Another well-known failure was the merger of Kmart and Sears Roebuck in 2005. Both companies were in decline at the time with major competition from upstart online retailers. Although the merged organization was the third-largest brick-and-mortar retailer in the United States, it never succeeded in developing a workable online sales strategy. The company filed for bankruptcy in 2018.
What Is an Acquisition?
An acquisition occurs when one entity is taken over by another. A new company is not formed, and the smaller company either ceases to exist or becomes a subsidiary. The acquiring company takes over the assets, liabilities, and decision-making powers of the smaller organization. Usually, there is little or no change to the leadership structure of the larger company.
Most corporate acquisitions involve asset purchases, in which the acquired company sells its business assets to the larger company; or equity purchases, where the acquiring company purchases a controlling interest from shareholders of the smaller company.
Sometimes an acquisition involves the sale of one or more units or divisions of a company, rather than the entire enterprise. There are also cases where, usually for tax purposes or to combat a bad reputation, a larger company may be acquired by a smaller one.
A friendly acquisition often occurs when the smaller company is distressed, or the company owners are desirous to move on to other pursuits, or it may be that the acquiring company simply makes an offer that is too good to refuse.
A hostile acquisition or “hostile takeover” may occur when the target company owners or stockholders are reluctant to sell. It can also happen when shareholders of the target company are unhappy with management and band together in a “proxy battle” to win the corporate vote. Sometimes the acquiring company will go directly to the stockholders to entice them to sell.
Examples of Winning Acquisitions
One of the most successful acquisitions to date occurred in 1999 when British mobile operator Vodafone acquired German industrial conglomerate Mannesman in a $203 billion hostile takeover, becoming the world’s largest mobile telecommunications company.
Another success was the 2019 acquisition of drug manufacturer Celgene by its rival Bristol-Myers Squibb. Celgene became a subsidiary of Bristol-Myers, and together they became one of the world’s largest suppliers of cancer medications.
Examples of Failed Acquisitions
In 2005, online auction company eBay acquired video communication company Skype, with expectations that buyers and sellers could easily communicate, thus increasing sales. Unfortunately, the two companies did not share any commonalities in culture or direction. Worse still, it turned out that eBay users had no desire to hold video meetings with sellers; they preferred email. After just four years, eBay sold off most of Skype at a $700 million loss.
In 2008, Bank of America acquired mortgage lender Countrywide at a “bargain” price of $2 billion. This was at the same time when the subprime mortgage bubble was bursting, and the national economy was tanking. Having failed to do its due diligence, Bank of America eventually wound up losing $50 billion on the deal.
What Should Be Done to Prepare for a Merger or Acquisition?
As evidenced by the examples above, one of the biggest factors in a failed merger or acquisition is the lack of proper due diligence. Once a letter of intent is signed, there needs to be a thorough disclosure of financial, organizational, and obligational data between the companies. This process will take considerable time and effort.
A full financial audit and company valuation, as well as a review of all existing contracts and corporate relationships, must be undertaken in each company. In addition, each company needs to look carefully at the structure, culture, and reputation of the other, to ensure a good fit. If anything seems out of order, it needs to be fixed before the transaction proceeds. If the situation cannot be corrected, it may be time to walk away from the deal. It is generally good practice to seek our experienced advisors for any merger or acquisition action.
Pros and Cons of Mergers and Acquisitions
When contemplating a business merger or acquisition, it is extremely important to weigh the risks against the potential benefits. A comprehensive financial picture of each company and solid forward-looking financial forecasts are essential. Companies that fail to do their due diligence in advance may sorely regret it later.
Here are some of the main advantages and disadvantages of a corporate merger or acquisition.
Advantages | Disadvantages |
Increased customer base, market share, and revenue | Corporate culture clashes and mismatched objectives |
Reduction of fixed costs due to consolidation of operations and departments | Layoffs, demotions, and key employee resignations due to restructuring |
New opportunities arising from the synergy of resources and technologies | Increased debt, greater accounting needs, and more management responsibility |
Increased market clout and greater ability to compete | Need for rebranding, rethinking sales strategies, and re-engaging customers |
Acquisition of new talent and new intellectual property | Need to reevaluate arrangements with suppliers, shipping companies, and service providers |
Increase in operating capital, real estate, and equipment | Possible negative consequences of the other company’s liabilities and reputation |
In Summary
A company that desires to expand may find great advantages in merging with or acquiring another company—but only if it’s done right. A merger or acquisition can help a business rapidly increase its market share, reach new customers, gain new assets, and improve its competitiveness. A merger or acquisition can be a faster, cheaper, and less risky means of growth than expansion of sales and marketing efforts.
However, there can be significant downsides to a merger or acquisition. You not only gain access to the other company’s assets, but you also acquire its liabilities, both tangible and intangible. Mismatches in culture, technology, and objectives can be problematic. Employees, suppliers, and customers may not adapt well to the changes. It may take a long time to work out the kinks and get the consolidated company running smoothly.
In order to make a wise decision about a potential merger or acquisition, it is critical to take your time and do a full cost/benefit analysis. You may need the help of an outside consultant as you make your due diligence efforts. If you would like expert financial advice, we invite you to contact Preferred CFO today.
About the Author
Kyle Hill
CFO
A veteran of the financial services industry, Kyle has served as CFO, COO, and Senior Auditor for organizations such as Arthur Andersen, LLP and CSI Capital Management, Inc. He has also served as the CFO for the general partners of Athlon Venture Fund I, LP and Dawson Real Estate Fund, LP.
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